By Tom Jackson
During the 2008 financial crisis Warren Buffett famously coined the phrase “only when the tide goes out do you discover who’s been swimming naked”. What was true a decade ago has been amplified with the current global economic crisis, writes Jean-Claude Homawoo, co-founder of Kenyan logistics startup Lori Systems.
In 2019, the valuation bubble of global “tech-enabled” business models that extended from San Francisco to Fukuoka quietly burst, exposing fundamental flaws in numerous global tech giants’ business models. Uber, Lyft, WeWork and Oyo to name but a few, raised mid-to-late rounds at astronomical valuations from investors who ignored gross margins, head scratching unit economics and unsustainable business practices in favor of top line “GMV” growth. By rewarding these practices, investors incentivised similar behaviour in other venture-backed companies, and encouraged sensational FOMO behaviour from investors to whom hype and perceived scarcity mattered more than practical pathways to gross margin profitability.
Later in the year, this folly seemed likely to subside when SoftBank’s Vision Fund I was forced to write-off massive losses from the revised valuation of numerous portcos, a moment punctuated by Masahiro Son apologising to SoftBank limited partners. At both the Goldman Sachs Private Internet Company Conference last October and Web Summit in November, building sustainable business models dominated the conversation. This reaffirmed my conviction that at Lori we needed a renewed focus on sustainable growth.
Josh Sandler (Lori co-founder and CEO), Uche Ogboi (Lori COO) and I discussed this with our leadership team and together set out to make the necessary changes across our business to ensure we accelerated this drive to profitability. As the world collectively settles into a new post- with-COVID reality, I am more convinced than ever that for the African continent especially, 2019 holds valuable lessons. We must forgo the so-called growth-at-all-cost (GAAC) strategies in favour of sustainable growth practices, to prevent our fragile African venture and tech ecosystem from suffering similar shocks which could have devastating consequences to our collective tech-fueled ambitions.
It’s hard to fault investor enthusiasm for the Africa tech opportunity. After years of false starts, 2019 was a great year for tech on the continent. Companies secured record amounts of investment, with Kenya and Nigeria emerging as premier investment destinations on the continent. As African startups like ours began to mature, global players such as CZI, a16z, DST and Goldman Sachs began investing. The entry of global venture investment actors into Africa’s fundraising market is a positive sign for the continent, flipping the script on the traditional narrative that African companies are not a fit for elite venture capital firms.
The opportunity is undeniable, but as Lauren Cochran notes, GAAC-scaling loss-making businesses in this environment is an “unsustainable concept”. GAAC of high-tech, high margin businesses have its merits, but this is a new breed of models. Tech-enabled companies that build software with physical world realities have different economics, and GAAC for that subset of business models never made sense, in any region. And yet less than a year after those high-flying startups were reappraised, we continue to see investors and founders, including in many of the world’s fastest-growing markets, make poor decisions that will endanger not just the health of their own businesses but that of their ecosystems as well.
Of the countless 2019 startup horror stories, WeWork ticked the box on all the cautionary tales. Questionable accounting, unsustainable valuation growth, scheming investors, and unethical business practices punctuated by an 87 per cent valuation drop all features in this story. Oyo’s story is another case in point. Oyo’s destructive unit economics turned a 4.5x increase in consolidated revenues for the year ended March 2019 into a 7x increase in losses to US$335 million.
What happens at Oyo matters for the startup ecosystem in India, but it also matters far beyond. If Oyo, India’s third most valuable startup with venture funds including SoftBank, goes bad, it will have far-reaching consequences for other emerging market startup and venture ecosystems. On the heels of the 2019 masterclass, and with the COVID-19 pandemic adding uncertainty to already unreliable capital markets, we continue to see companies live dangerously, pushing flawed growth strategies that mortgage the future health of their businesses to deliver vanity metrics today.
At Lori we’ve forced ourselves to think carefully about what sustainability means in the context of building a globally leading e-logistics company that lowers the cost of goods in many of the world’s fastest growing markets by delivering 10x efficiency improvements with technology – a US$200 billion market in Africa alone. We have been able to build a business that prioritises longevity, while driving rapid growth and expansion by avoiding shortcuts and prioritising innovation, which often requires extra effort and strategic design. To us, building a market leader will involve a focus on sustainable growth, unit economics, and scale through technology to ultimately impact the billions we serve across our focus markets.
Cash management: Conservative cash and credit management may seem obvious but require discipline. In logistics, a decent percentage of manufacturing and industrial customers are poor debtors. Lack of discipline driven by GAAC can easily lead to a situation where receivables balloon out of control. At a time when the COVID-19 crisis has strained many companies’ cash balances, we raised the bar on our credit scorecard for customers and were laser-focused on collections. We realised sooner rather than later that mixing GAAC with mismanaged receivables and negative unit economics in the current environment is a recipe for disaster. Because of this early realisation and the steps we took we were fortunate to achieve breakeven EBITDA in our biggest market, Nigeria.
Unit economics: Positive unit economics sound like another MBA-type truism that shouldn’t require a paragraph, but this notion has been under assault in this era of logistics and mobility as they were in the food delivery startup ecosystems in the US and India. Customers there turned out in droves for the incredibly low (and unsustainable) prices, subsidised by those companies under the guise of marketing spend. Without moats or switching costs to defend their expensively acquired customers, incumbents lost customers to the newest and cheapest entrant, leading the likes of Blue Apron, Munchery and SpoonRocket to their demise. Closer to home, SafeBoda, a leading transportation, payments and food delivery startup, experimented with growth tactics to scale to it’s one million plus customer base. As Alastair Sussock, co-CEO, explained, “promos and discounts can entice first-time users and one can see a certain level of retention from these adopters, but you can’t run away from the importance of customers’ willingness to pay for the product or service offered”.
Sustainable business fundamentals: Lastly, sustainable business practices may sound straightforward but can often be the first symptoms of a business model or strategy that are amiss. For an example look no further than WeWork and its CEO’s fall from grace. Among Adam Neumann’s many strange and unethical business practices were selling the “We” trademark to his own company for US$6 million, smoking weed on work trips, and employing family members in roles of questionable value. But unsustainable business practices need not be so egregious to lead to the same place. It is why we chose providing long-term value, avoiding unethical business practices in markets where they can be justified as “standard” and making technology the centerpiece of our strategy as key tenets, which led to our recent WEF Technology Pioneer Award. In emphasising our technology solution over throwing more cash at the problem, we believe we can reduce and eliminate many of the structural inefficiencies that plague frontier markets.
How tech in Africa plays out in this new decade is anyone’s guess but in companies like Paystack, Trella, Sokowatch, SafeBoda and many more, we see peers that collectively carry the ambitions of the next generation of entrepreneurs. With this comes the responsibility of building startups that create value, grow, exit and provide returns to shareholders while inspiring and funding the next generation. In their HBR article titled Building a Startup That Will Last, Ken Chenault (former CEO of American Express) and Hemant Taneja (managing director of General Catalyst) emphasise that “the potential for career-defining gains got the best of many investors and advisors, and [they collectively]failed to coach founders on the fundamentals of sustainability. We are only now recognising how untenable the “move fast and break things” attitude was to become”. Founders cannot build sustainable companies alone, they need investors to have the right incentives and reward sustainable business models over those that mortgage the future for short term gain. Only then will we make strides in building and scaling resilient frontier-market companies that can scale beyond the continent, generate alpha and set a new standard for African tech.
Tom Jackson writes on tech startups in Africa.